Gold stocks have
to be the most despised sector in all the markets. Mainstreamers
barely even know they exist, while even the vast majority of
so-called contrarians scorn them. The sheer contempt for this
sector is amazing considering gold stocks were almost certainly the
best-performing sector of the past decade. This universal antipathy
has driven them to panic levels, by far the marketsí best
fundamental bargains.

Gold stocks
werenít always held in derision. From November 2000 to September
2011, the flagship gold-stock index known by its symbol HUI
catapulted an astounding 1664.4% higher! This was over a very long
10.8-year
secular-bear span where the broad stock markets as measured by
the mighty S&P 500 fell 14.2%. After multiplying their
investorsí wealth by 18x, they should have been the
most-popular sector.

But Wall Street
has always hated gold, so there has never been adequate or fair
coverage of the secular gold bull or the resulting secular
gold-stock bull. When gold stocks are strong, they are ignored.
CNBC might spend a few minutes a day on them even if their gains
trounce every other sectorís. And when they are weak, they are
mocked. What kind of fools would want to grow their capital 18x in
a secular stock bear?

That ride was far
from easy, let me tell you. Weíve been trading great gold stocks
and silver stocks, and recommending them to our subscribers, for
this entire secular gold-stock bull. Itís always taken hardened
contrarians to weather this sectorís intense volatility. Like
everything else, gold stocks donít move in a straight line. There
were plenty of incredibly painful sharp plunges and big
corrections along the way.

The worst by far
occurred during 2008ís
once-in-a-lifetime stock panic. From March 2008 to October
2008, a very short 7-month span, the HUI plummeted a catastrophic
70.6%! Holy cow, you should have seen gold-stock investors then!
They were totally convinced the sky was falling, that the secular
gold bull was over, and that gold stocks were going to zero. The
wailing and gnashing of teeth was deafening.

Sounds like today,
eh? The recent totally irrational
gold panic
fueled by anomalous futures forced selling pummeled the gold stocks
down to prices totally disconnected from fundamental reality. The
current crop of pantywaist gold-stock investors literally panicked,
succumbed to their overwhelming fear rather than transcending
emotion to think rationally. Fear is transient, how did the
gold stocks look fundamentally?

Over the long
term, all stocks are ultimately valued based on their underlying
earnings streams. Legendary value investor Benjamin Graham, Warren
Buffettís mentor, described this valuation function of the markets
as a weighing machine. All stocks slowly gravitate to a
righteous fundamental price based on their underlying companiesí
profits. This includes gold stocks, which arenít exempt from market
laws.

But over the short
term, the powerful and dangerous emotions of greed and fear batter
stocks all over the place. After long uplegs greed propels stocks
to wildly-overbought levels totally disconnected from their
earnings. And after long corrections fear hammers stocks to
radically-oversold levels equally as absurd. Graham said that the
markets act like a voting machine in the short term, opinion
trumps fundamentals.

But emotional
extremes never last, they are fickle. Excessive greed or excessive
fear quickly burn themselves out, and stock prices resume their slow
fundamental march to reasonably reflect their underlying profits.
Gold stocks are now trapped in a voting-machine moment where
everyone hates them for irrational emotional reasons, resulting in
them weighing far less than their fundamentals demand.

At the S&P 500ís
last nominal
record high on April 11th, the collective price-to-earnings
ratio of all its component stocks was about 21.2x. General stocks
were priced at levels 21 times their underlying annual
profits. This is actually overvalued, pricey. Over centuries all
throughout the world, the
long-term fair
value of stock markets is 14x earnings. Markets trading above
this are expensive, and below it cheap.

Meanwhile on April
17th with gold-stock investors foolishly choosing to panic, the
collective P/E of the HUI gold-stock index was around 9.3x! Not
only is this the
lowest of gold stocksí entire secular bull by far, it is very
cheap in absolute terms. A dollar of earnings in gold stocks could
be purchased for just $9 in stock price, compared to $21 for general
stocks. Gold stocks were 56% cheaper than the rest of the
markets!

Now in most
sectors (not necessarily individual stocks), value investors
would flood in to buy companies at 9x earnings. It is a guaranteed
win over the longer term as the weighing function of the stock
markets overcomes the temporary swings in sentiment. And 9x for
gold stocks is far cheaper for this sector than it would be for
general stocks. Gold stocks usually trade at a premium due to their
very outsized returns.

Between 2007 and
2012, the HUIís P/E ratio averaged 27.9x earnings. This long 6-year
span included both major uplegs and major corrections, even 2008ís
insane stock panic. So by their own recent standards, the loathed
gold stocks are now trading at steep discounts of 2/3rds to
their normal valuations! The magnitude of this total fundamental
disconnect is mind-boggling, it makes no sense whatsoever.

Was Graham wrong?
Do earnings no longer matter? Are gold stocks going to be
perpetually hated and therefore never reflect their underlying
profitability? Of course not. The extreme fear holding down gold
stocks canít and wonít last. The markets have always abhorred
sentiment extremes, they are very temporary. And once they
inevitably pass, misvalued sectors spring back to normal relatively
rapidly.

This certainly
happened in gold stocks after that once-in-a-lifetime 2008 stock
panic. After plummeting 70.6% and stoking epic levels of gold-stock
fear that dwarfed todayís, in just 13 months the HUI had fully
bounced back. The weak-willed investors who succumbed to their own
fears sold near the bottom to set their terrible losses in
stone. But the strong contrarians held on to enjoy the massive
236.9% recovery.

By September 2011,
the gold stocks as measured by the HUI had more than quadrupled
since the panic lows with a staggering 319.0% gain over 2.9 years.
Why? This sector had been wildly mispriced when the vast majority
of investors chose to vote against it when they were blinded by
their own fear. But that fear quickly dissipated and the
weighing-machine function of stock markets gradually normalized
prices.

This background is
very important now because gold stocks are actually at more-extreme
lows today than they were during 2008ís stock panic! And if they
quadrupled after that panic anomaly, they are highly likely to at
least quadruple from their recent panic lows in the coming
years. This is measured by the all-important HUI/Gold Ratio. The
HGR is a simple construct that divides the HUIís close by goldís
own.

Obviously gold
miners mine gold. Their profits as a sector balloon when
gold rises and contract when gold falls. So the price of gold is
the overwhelming primary driver of gold minersí long-term
profitability,
which ultimately determines their stock prices. Thus the HUI/Gold
Ratio has been one of the best tools to measure how gold stocks are
faring fundamentally throughout their entire decade-long secular
bull.

This chart, long
one of my favorites, superimposes the HGR in blue over the HUI
itself in red. By this key valuation metric, gold stocks were just
driven to levels relative to gold well under even the crazy
2008 stock-panic levels! This is the biggest valuation anomaly ever
seen in this gold-stock bull by far, showing how excessive fear has
been. The market voting machine temporarily forced gold stocks to
ludicrous lows.

In October 2008 in
the dark heart of the stock panic when it really looked like the
world was ending, the HGR slumped to 0.207x on mind-boggling fear.
That turned out to be a 7.5-year low for the HGR, since April 2001
which happened to be the very month the past decadeís powerful
secular gold bull was born. Without context that HGR extreme is
meaningless, so this chart really puts it in proper perspective.

For 5 full
years before that ultra-rare fear superspike, the HGR traded in
a tight secular range between 0.46x and 0.56x. Gold stocks became
more valuable relative to gold when investors got greedy and loved
them, and less valuable when they got scared. But the HGR didnít
spend too much time far away from its secular average of 0.511x.
The HUI gold-stock index generally traded at half the
prevailing gold-price levels.

But the first true
stock panic in 101 years shattered this longstanding
fundamental relationship between the gold minersí stocks and the
driver of their profits. As gold-stock investors fled in terror,
gold stocks were driven down far faster than the also-weak gold
price. So the HGR plummeted, shattering support and falling to
levels previously unthinkable. It was very obvious
at the time
that this anomaly wasnít sustainable.

And indeed the
crazy-oversold gold stocks bounced back sharply, rallying far faster
than gold. At 0.437x in late 2009, the HGR had made up so much lost
ground that it was on the verge of breaking back into its pre-panic
trading range. But even though gold stocks kept powering higher
dramatically after that, gold climbed so fast in the Fedís
inflationary
quantitative-easing era that it kept pace with the HUIís big
gains.

So the HGR
stalled, starting to drift sideways between 0.35x and 0.40x or so.
But this new post-panic norm started to break down in the summer of
2011. That was when the anxiety about Washington technically
defaulting on Treasuries surrounding the last debt-ceiling debate
ignited a rare
sharp summer rally in gold. Gold stocks werenít as attractive
as gold in such a scary scenario, so the HUI lagged the metal.

And gold-stock
psychology, which had never quite fully recovered from the deep
scarring of 2008ís stock panic, started deteriorating rapidly as
both gold and gold stocks corrected after gold reached
very overbought
extremes in August 2011. Since gold stocks nearly always fall
faster than gold in a correction due to their profits leverage to
the metal, the HGR kept sliding lower and losing even more ground.

This long
downtrend finally started reversing late last summer when gold and
its minersí stocks surged after gold sentiment hit
unsustainably-bearish extremes. I explained the gold action
since in much depth in a February essay on
goldís
capitulation and last weekís essay on goldís
wild panic
selling. As gold continued to be sold off, the already-oversold
gold stocks started collapsing. This dragged the HGR lower still.

Just last week,
this key gold-stock valuation metric was pummeled to 0.187x. This
was a 12.0-year low well below even the level seen in 2008ís stock
panic! So relative to gold, gold stocks were just driven to
sub-panic levels. That extreme anomaly couldnít persist in the
stock panic and it canít persist today. Gold stocks have never been
so hated in their entire secular bull, meaning fear has to have
finally peaked.

Seeing a sector
that usually trades at 27.9x earnings languish at just 9.3x, a
2/3rds discount, certainly illustrates the fundamental absurdity of
todayís gold-stock prices to those familiar with valuations. But I
wonder if that can resonate well enough with less-studied
investors. So letís look at the HUIís ludicrous disconnect from
fundamental reality another way, from previous HUI milestones at the
same level.

At April 17thís
closing low of 257, the HUI was at its worst levels seen in 4.3
years. That very day, gold and silver were trading at $1374 and
$23.25. But the last time the HUI was under 257 in January 2009,
gold and silver were 41% and 55% lower at $810 and $10.50! And lest
you think gold miners were more profitable back then, they werenít.
The HUIís P/E then was 23.6x, far higher than last weekís 9.3x.

The very first
time the HUI challenged 257 in this secular bull was way back in
December 2003. Back then gold and silver were 70% and 76% lower at
$405 and $5.50! Seeing gold stocks trading at the very same
levels today with gold and silver 240% and 327% higher defies
all logic. This disconnect between gold stocks and their underlying
fundamentals couldnít be more extreme, it is ludicrously absurd.

Per the HUI/Gold
Ratio, gold stocks have been falling out of favor since either early
2006 or early 2011 depending on how far back you want to take the
trend. Does any market run in one direction forever? Will gold
stocks be hammered down to 7x or 5x or 3x earnings? The chance of
that within a
fundamentally-driven secular gold bull is likely zero. The
extreme antipathy to this sector will have to abate.

This one-way trade
of irrationally hating gold stocks and ignoring their
fundamentals has created a thriving cottage industry of analysts
and traders trying to rationalize all this as normal. There
are several major theses and countless sub-theories trying to
justify gold stocks trading as if their earnings will never matter
again. Traders as a group wax the most bearish at the
worst-possible times, right at major bottomings.

Earnings are the
only thing that matter for long-term stock prices, period. No
sector is exempt from ultimately being weighed and fairly valued.
And as long as the secular gold bull isnít over, which it canít be
without a proper
popular-mania climax, gold miners will remain very profitable.
Sooner or later their incredibly low valuations will matter, value
investors will move capital into the cheapest sector in the stock
markets.

I am probably the
last one on the planet, but as a rational contrarian I still expect
gold stocks to regain their pre-panic average HGR of 0.511x. Before
you laugh, realize not too long ago silver was in a similar
situation where everyone thought it was hopeless for it to regain
its pre-panic average relative to gold. But silver not only surged
to hit those levels once again as it returned to favor, it
far exceeded them
to the upside.

The markets are
tyrannically cyclical, every sector out of favor eventually returns
to favor again and vice versa. That law of sentiment is as
immutable as stock prices ultimately reflecting underlying corporate
earnings. Based on todayís still-battered gold prices, a 0.511x HGR
would put the HUI at 731. This is 157% higher than it was in the
middle of this week even after recovering 3/7ths of its gold-panic
losses!

And even if you
believe the bearsí endless rationalizations about why gold stocks
are doomed, consider the post-panic average HGR which includes the
extremely low levels of 2013. That is 0.338x. Even if gold stocks
will somehow never again be as popular as they were pre-panic, when
everyone but hardcore contrarians ignored them just like today, that
HGR with todayís gold levels puts the HUI at 484.

Which is still 70%
higher than this weekís horrendous gold-stock levels! With the
general stock markets very overbought,
hyper-complacent,
and at nominal
record highsin a secular bear, can you think of any
other sector with a high probability of climbing 70% just to return
to merely average? I sure canít. Gold stocks canít keep falling
deeper out of favor forever, there is no one left who doesnít
already hate them!

So if youíre a
contrarian, if you really walk the walk and buy low, gold stocks are
by far the most attractive sector in the stock markets today. Yes
itís been a tough 2013, but so what? The lower this sector is
pummeled the cheaper it gets, and the bigger and faster the
subsequent mighty upleg will be as sentiment inevitably turns.
Buying low and holding as prices are driven lower is irrelevant if
they are due to at least quadruple.

At Zeal it feels
like weíre the only ones left bullish on gold stocks. We keep
diligently studying them and buying them cheap. Weíve spent many
years researching most of them (many hundreds) to pick our
fundamental favorites. They are covered in depth in our popular and
fascinating fundamental
reports. There are no better profiles of high-potential gold
and silver stocks anywhere, so
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today and get deployed!

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The bottom line is
gold stocks have been driven down to panic levels by the recent
gold-futures forced selling. They have never been cheaper relative
to gold in their entire secular bull. They have never traded at
lower traditional valuations based on their underlying earnings.
And they have never been cheaper compared to their average
valuations of recent years or the general stock marketsí prevailing
valuations.

So naturally
everyone loathes gold stocks. Iíve never seen them so universally
hated and deeply out of favor. But this is a sentiment anomaly that
wonít last. Eventually all stocks are weighed by the stock markets
and priced to fairly reflect their underlying earnings streams.
Gold stocks are no exception. Their pricing anomaly is so extreme
today that it will take a gigantic upleg to mean revert to normal
levels.